The importance of managing our exposure to price/cycle risk

The Fed is accountable for the excesses of what led us into this crisis pre-subprime, according to Stephen Roach, Morgan Stanley Asia non-executive chairman, who says the lessons from Japan, is that the economy did not respond to quantitative easing and the same thing is happening in the U.S. We have not learned the lessons from Japan.

Stephen Roach is a good thinker and a very experienced and honest commentator on the global economy. Always worth the listen. But I find his arguments on why China may not correct significantly to be weak. Having been a ‘Asia bull’ for years I find that Roach tends to love the region and especially China at the expense of recognizing shorter-term investment risks. David Rosenberg makes a similar error about Canada in his optimism over the past many months for continued strength in the loonie and the Canadian economy, despite the onset of the next global recession and cyclical bear market in stocks. The evidence of the last 12 years simply does not support any of these theories or hopes. Global markets are incredibly correlated. They may lag each other in weeks or months, but they do not decouple from one another.

This point is reaffirmed this morning as the Canadian dollar tumbles below .97 US and in a global sea of red the Canadian stock market falls harder than most off nearly 4% today. It is true that Canada has lots of natural resources, and a more regulated banking system. It is true that China has more than 1 billion people all trying to move up the socioeconomic ladder. But from an investment perspective we must never lose sight of price risk and interim cycles. Everything depends on the relative price of these assets and the credit cycle. The Chinese stock market peaked out at 6,000 in 2007, crashed to 1700 in 2008, recovered to 3400 in 2010 and is today back at 2400. Being a China bull throughout this period would have meant a capital loss of 60% over the last 4 years with mind-boggling volatility that no sane person could stick.

The Canadian broad market is today back at the level it first reached in 2000, and some 25% below where it peaked last expansion in June 2008. The Canadian resource-rich venture exchange is today still down 52% from where it peaked in 2008, and is up just 13% in total since its 2000 peak–11 years later. So much for the secular bull in commodities;  good in theory, but not as an investment approach.

Be very leery of financial advice based on long-term bullish demographic, country or sector-specific arguments. It is much more likely to harm you (repeatedly) than help you.

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